Commercial leases are the foundation of a successful property portfolio. They do not only address rent collection, they also deal with issues that impact the long-term health and profitability of your investment. Effective commercial leases are built on strategies that consider these key issues:
- Use of the Premises
Leases dictate how your entire property functions. Strong “Use Provisions” clearly define what activities are allowed within each space. These provisions should work together with the use provisions of other tenants to create a positive environment and to create a strong mix of tenants. Well-drafted Use Provisions can build synergies and help you avoid conflicts between (and also with) tenants.
- Risk Management: Insurance & Indemnification
Commercial leases allocate risk between you and your tenant. Clear provisions define each party’s responsibilities and help reduce risk, such as requiring both to maintain insurance. These provisions may also include “indemnification,” where one party agrees to cover the other’s losses in certain situations. This applies to both individual premises and overall common areas of your property. Getting this right is crucial for minimizing risk.
- Optimizing Tenant Contributions
Leases come in many structures. A Ground Lease allows a tenant to build and maintain their own building on your property. In contrast, a common NNN lease means you, the landlord, take on significant responsibility for maintaining the property outside the tenant’s space but then bill most of those costs back to the tenants. Every lease structure has its own considerations to protect your interests. A well-crafted lease makes the property easier to manage, with tenants contributing fairly to the upkeep. Mistakes in this area can leave you responsible for costs you shouldn’t have to bear.
- Tenant Creditworthiness
Reliable, creditworthy tenants are essential. Thorough tenant screening, including reviewing financials and guarantor qualifications, is key. Leases with poorly drafted “assignment provisions” can create loopholes that allow tenants to escape their financial obligations and possibly leave you with an occupant who is unable to meet its financial (and other) obligations.
- Clarity on Maintenance: Defining Responsibilities
A well-maintained property attracts and retains quality tenants. Well drafted lease terms outlining who is responsible for what repairs and upkeep minimize confusion and prevent future disputes.
- Lease Duration and Renewal Options
The length of the lease and the terms for renewal can significantly impact both landlords and tenants. Rent escalation clauses are discussed below. Tenants also frequently desire lease renewal options and early termination conditions. Understanding these terms (which are not often beneficial to landlords) is essential in determining whether to include them in a lease and also helps in planning long-term investments and maintaining stable occupancy rates.
- Rent Escalation Clauses
Addressing how rent will increase over the term of the lease is crucial. This can be based on fixed increases, percentage increases, or tied to an index like the Consumer Price Index (CPI). Clear rent escalation clauses help avoid disputes and ensure the investment keeps pace with inflation and market conditions.
- Subleasing and Assignment
Tenants might want the flexibility to sublease or assign the lease to another party. Provisions governing subleasing and assignment can protect landlords by ensuring new tenants meet financial and operational criteria. This also helps in maintaining the integrity and quality of tenants in the property.
- Default and Remedies
It is essential to define what constitutes a default under the lease and the remedies available to the landlord. Remedies can include late payment penalties, rights to terminate the lease, or re-enter the premises. Clear default and remedy provisions provide a legal framework to address breaches of the lease agreement.
- Environmental and Compliance Issues
Including provisions that address hazardous substances, environmental responsibilities, and compliance with local laws and regulations can help prevent future liabilities. This can be particularly important for properties used in connection with certain industries that use materials or generate waste that might impact the environment.
- Tenant Improvements and Alterations
Clarifying who is responsible for tenant improvements and any initial as well as subsequent alterations to the leased premises is vitally important. This includes specifying the approval process, standards for construction, and responsibilities for restoration at the end of the lease term.
Crafting effective commercial leases requires a comprehensive approach. Consulting with experienced legal counsel ensures your leases are strong, enforceable, and contribute to the long-term success of your property.
